Interview With James East: Finding Opportunity Worldwide

James East delivered an 11.3% return annually since his partnership’s initiation in 2007

It is just plain common sense to buy low and sell high. Yet although everyone can easily observe the wide variation in stock prices, it seems that very few of us are able to do so.

James East has a proven track record and is one of those very few outsider investors. He has delivered an 11.3% return annually since the partnership’s initiation in 2007. Moreover, he directed one of the very few funds in U.S. that delivered positive returns during the 2008-09 financial crisis while avoiding derivatives and short selling! Surprisingly, from what we learned from our last interview with East, he afforded little attention, if any, to macroeconomic conditions. Instead, he is very much micro-oriented toward buying individual stocks and part ownership in businesses with significant margins of safety.

ACI Partnership Fund LP is run based on Warren Buffett (Trades, Portfolio)’s original partnership agreement, which always had a 0% management fee with a hurdle rate of 6%. His model is very similar, with a hurdle rate of 6.3% and 30 basis points of management fees. This is a model Charlie Munger (Trades, Portfolio) also used for his own early partnership, and here’s his quote from a Daily Journal meeting: "I did copy the Buffett Formula more or less, and I do think it’s fair and I think it’s still fair… I wish it was more common.’’

East was one of the gurus selected for the 2016 GuruFocus conference in Omaha. We also covered him in an interview published two years ago. Again, we are very grateful to East for agreeing to meet us again in 2017. Time has passed, so the stocks discussed in this interview are undoubtedly now trading at different prices, yet I felt his words well worth conveying to you all.

Can you tell us a little about your performance over the last few years?

Like for most value investors, the last few years have been a little tough. We rebounded a little bit in 2016, being up around 16%, which is little above S&P but we had a tough 2015 as we underperformed the S&P500. I think this is the general sentiment for most value investors, that the environment over the last few years has been tough for them as the market continues to expand and the price-earnings (P/E) ratios continue to rise. It’s a little tough for value investors as it’s not the landscape we normally perform well in as we, as a group, perform better in flat-to-down markets, not during late stages of a bull market.

In that regard, do you think the market is overvalued?

In North America, the market is probably fairly valued, not nearly overvalued as in ’98-’99 or ’07, and also there’s not a lot of opportunity from a value investor perspective in North America. However, outside of North America, I think the opportunities are still there, as the world wants to own the U.S. dollar and we have been given opportunities outside of our country.

So right now you are not adding any new stocks in the U.S.?

Not in the U.S., but for the last year, we have been adding positions outside of North America.

Can you give us some names of companies you have been adding from outside of North America?

Sure. Over the last 25 years, people have been saying that Japan was a lost cause, even if the value has been there for years. I think the dynamics of Japanese corporate laws are changing to provide for better corporate governance from Japanese companies deploying capital; better at giving capital back to shareholders. I think there is a lot of value in global Japanese companies that are presently unrecognized. For example, one of those companies is called Toyota Industries. It is the world’s largest forklift operator, part of a somewhat duopoly of forklift operators, also one of the dominant players for automobile air compressors. Right now the world production of automobiles is about 90 million cars per year, and Toyota Industries produces about 30 million air-compressors a year. Also, there is a current change in the type of air compressors that are being produced and manufactured because of new regulation for better fuel efficiency and lesser CFC. Now, most air-conditioners operate on fixed displacement, and to be more efficient they use a variable displacement, which is a more efficient and more complex air compressor for automobiles and light-trucks. They are the dominant player in air compressors. So, if you think the automotive industry is going to continue at a robust level, as I think it will, it is a very good opportunity for this Japanese global exporter. We bought it when it was selling at maybe 60% of book value, yielding 2-3% while you wait. They also own about 7% of Toyota Motors within the company.

Another area that has been interesting is the shipping industry, which is in a secular downturn from peak, and a lot of the shipping companies are down 60%, 70%, 80% from the peak. One interesting company in Norway is called Stolt-Nielsen; we bought it when it was selling at about 60% of book value. It pays a U.S. dividend yielding about 7%. There is some consolidation in the chemical tanker business transporting chemicals around the globe from Houston, to China, Australia, parts of Africa and Latin-America. Some consolidation is also going to take place in the next couple of years, and I think it is a great opportunity with that particular company. They are a really well-run company. They even made money during the financial crisis; it is a very special type of chemical shipping company, highly regulated, enjoying long-term relationships with their customers, who don’t want sticky food oil in any type of containers, unlike dry bulk. If you are just shipping coal it doesn’t really matter who the coal for you. For a greater quality of chemical, it becomes more important to have stainless steel containers, a highly regulated and high-quality type of company, with good logistics affecting time of delivery.

You are really focusing on industrial companies, aren’t you?

Yes, what do you look at for value? You want to partner with folks you can trust, that have a long-term record that has shown that they have been successful in the past, that they can run into a speed bump or a pot hole, and come thru the cycle OK. This has happened in the shipping industry, and then run into a huge cyclical downturn starting around late 2014-2015. Some are down 70-80% from the peak.

Do you still own Republic Insurance?

No, we sold that one. It was a profitable investment, it had a good run but we already had enough insurance given our large position in Fairfax, so we moved on.

How about DreamWorks?

Part of the thesis was that it would eventually be bought out at around $40 a share, and it was bought at $41, so we sold that position also.

You told us about Japan. Any other country you are looking at?

It is a little more speculative investment, but very inexpensive in Australia. The commodity industry is also at a low peak in Australia, down 60-70% for a lot of these companies, maybe 80% for some. We found an interesting mining service company, high quality, underground diamond drilling services company called Swick Mining Services. We think they are the highest quality operator, with about a 40% market in Australia. Selling at 60% of book value, it’s basically breaking even now, but if commodities -- primarily zinc, copper and gold -- if the animal spirit comes back to those industries, then the mining companies will have to explore more and utilization will go up on the rigs. I think it is a fine company with some optionality which is not priced in the market.

Why do you think it is speculative?

During the downturn, they were hurt, but they basically broke even. The company is very well-managed. Ken Swick is still the majority owner of the company with about 25-30% of the stock, and manages it very well, managing their debt level. Again it’s about at 60% of intrinsic value. But again it is a little more speculative, not our normal type of investment because it is somewhat commodity-related, but with the right people at the right price, it seems like an investment with low downside risk and asymmetric on the upside.

How many stocks do you own now?

Right now we have 20 stocks; our by-laws say we can’t own more than 25 positions. We think there is a lot of opportunity outside of North America and this is where we've been putting most of our capital over the last year, outside of North America. Every now and then we look at North America, but for now, we primarily see good investment opportunities outside of North America with our go-anywhere opportunistic approach.

Do you have to increase your position in bonds and cash considering the valuation?

Surprisingly, you would think with the North American market near fair value, and not a lot of opportunity, that we would not be deploying capital, and we are actually near the lowest cash level that we have been over the last six-to-seven years, just because there is value out there. Ironically, with the indexation factor, because of the passive investing getting more and more popular, that may potentially open up more opportunities; we may get in a stock picker’s market again. With index indiscriminately just buying the biggest of the big and as more money comes in index funds, the bigger just get bigger, which also opens up a pocket of opportunities for mispriced smaller securities. I think in the coming years we are going to return to more opportunity for active managers to get back to stock picking, unlike what we had in the last four-to-five years.

How do you see the risk of investing abroad when related to the risk of currencies?

That’s always the case from a U.S. perspective when you invest outside of the U.S. You are really making two investments: You are making an investment in the company and the people, but you are also making an investment in the foreign currency. From my perspective, we’ve had a four-to-five-year run in the U.S. dollar appreciation across the globe. Given where we were and where we are now, there seems to be opportunity to be actually invested in the non-U.S. currency. So if you are buying one of these non-American companies, dominated in non-U.S. currencies, if it does turn, you are buying at the right price with the right people. You may get a double benefit both with a revaluation of the company and also another benefit from the currency exchange. Extra tail wind potentially.

Have you looked at other types of securities such as bonds, convertibles, and derivatives?

They occasionally come up, but primarily I focus on equity investing, which doesn’t mean I won’t be opportunistic. I have invested in distressed bonds. I also invested in convertibles before, and private placements occasionally come up, which we are not opposed to. We made a private placement a few months ago. It was a small company, and it was more efficient for them to do a private placement then go to the market.

What type private placement would you look at?

It would be a special situation, which means you really have to know the management. You really have to know the business and the people involved. It has to be very opportunistic.

Anything you would like to add?

I think the big thing is that the North American market values are fair. They are not extremely overvalued. We can still do OK for the next couple of years in North America, but the opportunities are really outside of North America. The currency issue can act as a tailwind for North American investors investing outside of North America. The Buffett Partnership model is, I think, the fairest. People are concerned about expenses and active management that hasn’t performed in the last few years, but I think it’s going to change in the next wave because value investing has been out of favor for so long now. I think we are at a point where active management will add value as it has in the past. We will see.

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